Wednesday, April 06, 2011

The U.S. transformed into consumer economy that is exquisitely sensitive to debt and the costs of servicing credit. In other words: the bill is finally due, Baby.

One of the foundations of modern economics is the belief that insatiable demand for more goods and services is a permanent feature of humanity. This is also the basis of that other foundation of modern economics, the extension of credit so consumers can buy more now than their savings would otherwise allow.

It was a match made in Heaven--insatiable demand and nearly unlimited credit.Want a shiny new car, but have saved no cash? Not a problem. It will only take a modest monthly payment for 5 years (or longer) to indulge your impulse to have a shiny new vehicle to reflect your individual glory and unique personality (never mind the vehicle is mass-produced; it was "customized" just for you).

The "invention" of mass-marketed credit was one of the great innovations of capitalism. In the Depression, my grandfather paid $1 a week toward my Mom's first bicycle. The town's shopkeeper extended the credit, took the risk of non-payment and earned the interest.

Credit in modest amounts has positive features; with cash in short supply, the storekeeper probably had to extend credit just to book enough orders to keep the doors open.

On the consumer side, if servicing credit costs $1 out of a weekly paycheck of $25, then it's a modest tradeoff with substantial benefits.

In the late 1960s, a new innovation appeared: credit cards, a magical rectangle of thin plastic which enabled consumers to buy virtually anything they desired right on the spot. "Impulse buy" became a reality for anyone who qualified for the magic card.

There is of course a "marginal return" aspect to consumption. The first piece of chocolate cake is heavenly, the second is rewarding, and the third, hmm, no so amazing. Each succeeding piece carries a higher cost and a lower reward/return.

Thus is consumer ennui born. After a steady diet of continuous buying and consumption, the consumer finds less and less satisfaction from the ownership; soon, only the act of acquisition/purchase creates the "high" of satiation and excitement.

Alas, this hit of self-renewal and self-expression via consumption is also prone to habituation. The satisfaction of buying something new only lasts a brief time, a period that becomes shorter as the purchases pile up. Like the rat on the wheel in the cage, it becomes increasingly difficult to buy enough to keep the high going.

There are also some practical limitations, such as where to put all the crap you've bought. Luckily, ever-resourceful capitalism has the answer: self-storage units, which act as "cheap" extensions to store your valuables.

Maintenance costs are another bedeviling practicality. The fun boat must be moored or stored, the third car/truck's insurance must be paid, the vacation home's water lines froze, and the languishing spec house's property taxes--mysteriously higher every bill--must be paid lest the investment to date be lost entirely.

So there are two problems with the consumerist paradise that is the foundation of the U.S. economy. One is that people slowly awaken to the realization they don't really need additional goods and services, as their attention becomes focused on preserving their access to those they suddenly value, such as shelter, food and electricity.

In moving (out of a foreclosed house or on to another job, etc.) they suddenly feel the great freedom of no longer being enslaved to all their stuff; they realize it owned them, not the other way round.

In having to come face to face with their mountains of "cute blouses," old electronic toys, busted Ikea furniture, bicycles nobody rides, etc., then they slowly realize the return gained from buying all that stuff was increasingly marginal.

They might also awaken to the reality that partly why they have no capital or assets is that they squandered much of their income on instant gratification and marginal-return toys of various sizes and shapes, and costly "experiences" such as fine dining and cruises.

It is perhaps no coincidence that the wasting disease tuberculosis was once known as consumption. A single-minded focus on consumption is wasting to assets, income and the soul, and it eventually hollows out the economy built on its reedy, rot-riddled pillars.

Eventually, the costs of servicing the ever-rising debt and maintaining all the stuff exceeds the income of the consumers. I think we're approaching that point as housing declines in value and the costs of credit are rising, despite the Fed's claim that it can hold interest rates near zero forever ("Away, tides, I am Ben Bernanke and I speak for the mighty Fed!")

So what happens when demand stagnates and credit is denied or renounced? For one thing, all the stuff which people can no longer afford will be dumped, as correspondent E.P. recently noted in an email:

Debt/credit is such a distorter of the reality of value and economy. It is so hard to find realistic sellers. I just offered $15k on an older boat to which the seller laughingly responded 'you know the asking price is $50k?'. I nicely mentioned asking prices mean nothing these days and there simply aren't enough uberrich to buy all the luxury assets floating around. Its been sitting there for nearly a year...along with several homes we've made appropriate bids on that often eventually sell for less, or are still sitting there, empty. Simply amazing.

Do you foresee stockpiles of cars/boats/planes in the coming years? A colleague mentioned if we remain patient and wait long enough these things will be available at no charge, simply to be able to afford the maintenance and operation costs....

Presciently said, E.P., thank you. I would add houses to the list.

Everyone who is currently confident in high-inflation-hyperinflation is recommending buying tangible assets. Perhaps that should be narrowed somewhat to tangible assets with a positive return on investment. It seems very likely that the U.S. will be awash in surplus boats, yachts, cars, trucks, houses, exercise machines, etc., as the "owners" (if you bought on credit, and it's now worth less than you owe, then what do you own?) will no longer be able to pay the slip fees, registration fees, insurance premiums, mortgages, property taxes, storage unit fees, etc.

No, conventional economics, demand is not insatiable or permanent, and neither is credit expansion.

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